Property taxes are an ongoing cost that gets rationalized with higher rents in multifamily housing.
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It is axiomatic that costs incurred in the financing, construction, and operation of multifamily housing get passed on to consumers in the form of higher rents. This can be a source of debate, however, when proposals like rent control are proposed. It’s not worth rehearsing those arguments here. There simply isn’t any other way to offset costs except for rental income. One of those costs is property taxes. Eliminating or reducing those costs as an incentive has proven to be a successful strategy to create more market rate and affordable housing. It is worth looking at this approach in general, and then at some specific programs in subsequent posts to understand better how they work.
How Does Property Tax Work?
Property taxes in the United States have been around since before the Revolution and fall into two categories, real property taxes and taxes on tangible, personal property. We’re concerned with the first variety, land and buildings versus tangible property, things like equipment or vehicles, for example. From here on, when we refer to “property taxes,” we’ll mean real property taxes.
Typically, property taxes are assessed ad valorem, a Latin term meaning toward value, or based on the value of the property. There are three ways to assess value. Sales evaluation or appraised value, based on replacement cost, or based on the income a property generates. In the first value is determined by a property’s market value through appraisal. How much would a property fetch if it was put up for sale. The cost method assesses how much it would cost to replace the property if it were lost or if there was nothing on the property. This can track with market value or be very different. And the income method looks at the revenue generated by the use and function of the property, including retail sales or rents.
It is important to note that in some jurisdictions, like Washington state, assessors look at the value of all the property in a taxing district and then apply rates back onto individual properties based on their value. This method of taxing property is sometimes called a “budget based” taxing system, because a taxing district determines how much tax they want to raise, then value of the district is assessed, then the tax is applied to properties based on each $1,000 worth of value. This means that an individual property pays a portion of the tax based on value rather than based on the value of the property itself.
This brings us to something called mill rate or millage. The mill rate, articulated by Investopedia, is “the amount of tax payable per dollar of the assessed value of a property. It is a figure that represents the amount per $1,000 of the assessed value of the property, which is used to calculate the amount of property tax.” Usually, the mill rate is expressed as “per $1,000 of value” to more easily understand how much a property owner will have to pay. A tax of $1.86 per $1,000 of value would be $186 on a property with an assessed value of $100,000.
Finally, there are other factors like the timing of property taxes that have a significant impact on cost. Often, jurisdictions will assess value on a particular date. Taxes also are regulated by an array of constitutional and statutory limitations on how value is calculated, when it is calculated and applied for tax purposes, rates, categories of taxation, and rates of increases over time. For example, a jurisdiction could assess a property’s value on January 1 of each year and increase it if there are any improvements when any are made while another jurisdiction will not assess improved value until the following January.
A jurisdiction might only be able to increase property taxes at a rate of 3% for commercial property and 1% for residential property regardless of the assessed value of specific properties. Government choices about how much revenue they raise using property taxes, the rates they charge property, and limits they set on increases, highly determine the costs of building multifamily housing. These conditions vary widely from state to state, and jurisdiction to jurisdiction.
Tax Abatement and Exemption as an Incentive
Adding to this thicket of various rules and regulations, there are many exemptions to and reductions of taxes on property. States, for example, usually have some sort of exemption for seniors who pay taxes on their homes.
Abatements the rate of tax collected over time for affordable housing while exemptions for affordable housing are usually time limited and conditional lowering or removal of tax obligations on a property. When, as a matter of economics or policy, a jurisdiction takes seriously the idea that property taxes are suppressing new development of housing, they sometimes take measures to remove tax obligations on property to remove those costs as a way to motivate new development.
The variables on these kinds of tax abatements and exemptions are usually amount the forgone tax revenue to the jurisdiction, the length of the tax exemption for the property owner, and the performance requirement for the property owner. For example, a jurisdiction could grant an exemption on payment of all property taxes on vacant land for 20 years provided that a developer builds apartments that set aside 20% of the units for people that earn 60% of area median income. We’ll take a look at some of these programs and what can be learned about what sorts of abatement programs yield the best results for affordable housing.
